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Investment in UK Property for Non-Residents: Tax-Efficient Structuring via Cyprus

Article contributed by Mr Terence Pay, Head of Tax at Verfides.

The trend of significant international investment in the UK real estate market, particularly high-end property in London, continues to grow with renewed opportunities to benefit from significant capital growth and rental streams. 

Investment in UK real estate must be structured carefully in order to mitigate UK tax at source on income, gains and transactions. Taxes may be levied on rents, development profits and capital gains, and there are also stamp taxes and inheritance taxes to consider. 

Below we outline various structures aimed at sheltering property investment from UK tax.

Scenario: Individual purchase of one of more UK properties
Whether you are looking to purchase a single UK property for the purpose of using as a London base, or perhaps wish to develop a portfolio of properties under single ultimate ownership, it will be critical to structure the investment in a tax efficient manner. 

Some key facts are as follows:
  • A non-resident is not subject to UK tax on capital gains, even when such gains are derived from UK sourced assets. This includes a non-resident individual, partnership or company. Investment properties can therefore be sold at a gain in the future without tax consideration (it should be noted however that there may be a different tax treatment where a property is acquired, developed and sold in a relatively short period of time, hence deemed to be trading activity).
  • A private use property will not be subject to any taxes on (deemed) income in the UK whilst the owners remain non-resident for UK tax purposes. In contrast, profits derived from UK rental receipts are taxable in the UK in all cases, on the following basis:
    1. Non-resident individual owner: at a rate between 20% and 50% on income, depending n the level of profits;
    2. UK resident company: 26% on income and gains;
    3. Non-resident company: 20% on income only.
  • An overseas landlord is required to register with HMRC under the Non-Resident Landlord Scheme. Furthermore, 20% tax must be withheld by the tenant or agent from net rents, however, approval can be obtained from HMRC for rents to be paid gross, provided that an annual tax return is filed and tax paid on time.
Tax Planning

It can be seen that it is preferable for the investment in UK property to be structured through a non-resident company, preferably in a low tax jurisdiction such as Cyprus.

Furthermore, in order to reduce net rents chargeable to UK tax, it is often advisable for the shareholder to debt finance the non resident company the funds necessary to purchase the property. Such interest expense represents an allowable deduction from rents. 

UK tax issues will include the following:
  1. The loan should be secured on the property in order to obtain the maximum deduction on arm’s length principles under the UK transfer pricing legislation.
  2. There must be a commercial level of equity contribution.
  3. A suitable interest rate should be used.
  4. Planning should be undertaken to ensure the interest paid has a non-UK source, to avoid UK withholding tax. In many cases the shareholder advancing the loan will be a second BVI or offshore company which will not be chargeable to tax on its interest receipts.
  5. A further advantage in using a non-UK company is that it eliminates exposure to UK inheritance tax (IHT). UK IHT is levied on all UK-situated assets on the death of the owner, regardless of residence or domicile status. The tax is levied at a rate of 40% above a threshold value of £315,000. By using a non-UK company (note that the requirement is for a non-UK incorporated company, not merely a non-UK resident company) the assets comprised in the estate on death are shares in a foreign company rather than the UK real estate. Such shares are exempt from IHT for a non-UK domiciles.

Classic UK property ownership structure:

Classic UK property ownership structure 

Collective Investment Schemes for UK Real Estate

Although there are many individual private investors in London real estate, a collective investment scheme or fund is often required to generate sufficient purchasing power and / or leverage. As such, collective investment schemes have become popular over the last ten years at both the public and private level. 

This article will analyse the use of a Cyprus Private International Collective Investment Scheme (PICIS) for investment in the UK properly market.

Authorised Funds with Diversity of Ownership

At the public level, the UK introduced the Real Estate Investment Trust (REIT) in 2006. The REIT is a listed fund undertaking a property rental business and is thus applicable to both retail and institutional investors. The advantage of a REIT is that income and gains are not taxed at the REIT level, although withholding taxes often apply on distributions to investors and there is an annual requirement to distribute up to 90% of property related profits. Due to the listing requirement a REIT is not suitable in structuring a private property fund. 

As an alternative to the REIT, the Property Authorised Investment Fund (PAIF) regime was introduced to allow a tax exempt property fund to be formed without a listing requirement. The tax benefits are broadly similar to the REIT, but again withholding taxes will often be levied on distributions from the fund. Despite the reduced scale of the PAIF, there is still a rigorous “diversity of ownership” requirement, meaning that smaller groups of investors will still not be able to benefit.

Authorised UK real estate fund:

 Authorised UK real estate fund:

Private Property Fund Vehicles

As a result of these restrictions, non-UK based fund structures have emerged which are able to provide similar, or more extensive tax advantages without the ownership restrictions placed on UK-based schemes. 

In particular, the Cyprus Private Fund or ICIS is ideally suited as a private collective investment scheme for UK property. It combines the benefits of an EU-regulated fund which, when effectively structured, can achieve very low UK and overseas tax leakage. Cyprus funds are a good on-shore alternative to the traditional unit trusts established in Jersey, Guernsey or the Isle of Man, or may be combined with a traditional tax-efficient offshore investment structure. 

Carefully structured financing, in accordance with UK transfer pricing principles, can reduce the UK tax charge significantly, whilst the profits received in Cyprus as dividends are not subject to tax. Dividends and / or interest can then be paid out to the ultimate investors free of withholding tax.

Cyprus Private Fund for UK Rental Structure:

Cyprus Private Fund for UK Rental Structure

Simple Co-Ownership Structures

A group of investors looking to come together to invest in a particular project may consider forming a UK Limited Partnership, typically where they are not looking to attract further funds in the future from other investors. Each partner contributes funds to the partnership and takes an interest in the underlying partnership assets and income as a limited partner. As a limited partner, liability is limited to the sum invested and undrawn profits. 
The partnership is transparent for UK tax purposes so that only income (not gains) arising in the UK will be taxable on the members. An unlimited partner, often an offshore company, is appointed to manage the assets but has no participation in underlying income or capital. 
The advantage of a limited partnership structure is its flexibility, in that relations between partners are governed by a partnership agreement which can be altered at any time by agreement. The disadvantage is that the structure is relatively illiquid, unlike a fund where units or shares may be traded more easily. Care must be taken in structuring borrowings to reduce the UK tax charge, as there are restrictions applicable to partnership structures.

Limited Partnership Structure:

 Limited Partnership Structure

Planning for UK Property Developments

The UK property development market is also picking up again and has been a popular investment choice for non-residents over the last 10 years. 
A site is typically acquired, developed and then sold on at a profit in a relatively short period of time. Such an activity is considered a trading activity in the UK, subject to income taxes on trading profits. As such the amount of tax at stake is often considerable and careful planning is required. 
Short-term developments may avoid UK tax altogether when the developer is a company based in a jurisdiction with which the UK has a suitable tax treaty. The treaty should state that a building site does not constitute a permanent establishment (PE) until the expiry of 12 months. This has typically involved the use of companies in Jersey, Guernsey or the Isle of Man. 
Most developments last longer than 12 months and therefore a PE in the UK is unavoidable. In such cases, planning can be undertaken to ensure that only profits directly attributable to the PE come into charge to UK tax. With careful planning, significant pre-development profits, such as increases in value on securing planning permission, can be kept out of the UK tax net. 
Such an offshore development vehicle is particularly attractive when combined with a Cyprus private fund, allowing a bespoke group of investors to collectively finance a development. There will be no further tax on the dividends received in Cyprus from the Jersey company, as they derive from a trading activity

UK Property Development Structure:

 UK Property Development Structure
Summary

UK real estate continues to represent an excellent investment opportunity for non-residents. Structured carefully, the UK and international tax leakage can be minimised. There are also opportunities for collective investment in UK property within tax-efficient structures, particularly the Cyprus PICIS as detailed above.